Policy Uncertainty, Bad News Disclosure, and Stock Price Crash Risk

Abstract

This paper documents that policy uncertainty reduces future stock price crash risk. Our tests show that this negative relation is more pronounced among firms with more short-sale constraints, with no actively traded credit default swap contracts, or with higher firm-level political risks. The results from regressions adopting the instrumental variable approach and from a quasi-natural experiment suggest that the negative relation observed between policy uncertainty and stock price crash risk is unlikely to be driven by potential endogeneity. Additional tests show that this negative association is driven by firms’ decreased hoarding of bad news during periods of high policy uncertainty.

Keywords: economic policy uncertainty, stock price crash risk, accounting, disclosure, litigation risk, bad news hoarding

JEL Classification: G30, G38, M40, M48